Will DOL's Fee Disclosure Rule Enlighten Participants?

Many still will not know the precise dollar amount of fees charged to their accounts

By Michael Webb, of Cammack LaRhette
3/25/2011

Added 2/3/2012:

DOL Sets Deadlines for Service Provider and Participant-Level Fee Disclosures

The U.S. Department of Labor's (DOL) Employee Benefits Security Administration (EBSA) published its long-awaited final rule, "Reasonable Contract or Arrangement Under Section 408(b)(2) – Fee Disclosure," in the Federal Register on Feb, 3, 2012. The final rule requires retirement plan service providers to disclose to plan sponsors the administrative and investment costs associated with their plans. It extends the effective date to July 1, 2012, for new and existing contracts or arrangements between service providers and plans covered under the Employee Retirement Income Security Act (ERISA).

Another set of required fee disclosures, from plan sponsors to 401(k) plan participants (participant-level fee disclosures), is set to take effect 60 days after the service provider fee disclosure deadline. Due to the extension of the effective date of the final rule, plan administrators for calendar year plans now must make the initial annual disclosure of "plan-level" and "investment-level" information (including associated fees and expenses) to participants no later than Aug. 30, 2012, and the first quarterly statement (for fees incurred July through September) must be furnished no later than Nov. 14, 2012.

What a busy year 2010 proved to be for the U.S. Department of Labor (DOL) on the fee disclosure front. First came the 5500 Schedule C disclosure requirements, followed by the section 408(b)(2) interim final rule on required vendor fee disclosures to plan sponsors, and finally the long-awaited final rule regarding participant fee disclosure.

Over two years in the making, the final rule on disclosing participant fees presents the greatest challenge to HR. The rule amends the regulation under section 404(a) to provide standard fee disclosures to all Employee Retirement Income Security Act (ERISA)-covered retirement plans where participants direct their investments, whether or not the plans are defined contribution plans intended to be covered under 404(c). In that sense, the rule essentially eliminates the 404(c) distinction with respect to fee disclosure.

The new fee disclosure requirements do not extend to plans that are ERISA exempt, such as governmental plans (including public school districts), nonelecting church plans and plans of 501(c)(3) tax-exempts that satisfy the DOL’s regulatory safe harbor under 29 CFR 2510.3-2(f). Also, the rule does not apply to individual retirement accounts (IRAs) and IRA-based retirement plans, such as SIMPLEs and SEPs.

However, retirement plan vendors might provide the new disclosures to non-ERISA plans as well, for purposes of consistency.

The participant fee disclosure rule takes effect for plan years beginning after Nov. 1, 2011, (the 2012 plan year for calendar-year plans). Note that, technically, the “plan administrator” will be responsible for compliance with the new requirements. But much of the data required for compliance resides with plan vendors, who will likely provide the required disclosures.

The DOL's Model Comparative Chart

Will the new rule truly accomplish its objective of enlightening participants as to the fees they are being charged? Numerous surveys have indicated that many participants believe that their retirement plans are completely “free,” notwithstanding that a number of plan vendors have voluntarily enhanced their fee disclosures. So it may take a lot more than a new DOL rule to change that perception. In order to answer this question, turn to the Model Comparative Chart provided by the DOL.

The required elements of the chart are:

1.Performance information.Though the vast majority of investment providers provide returns for one-, five- and 10-year periods since inception, some providers don’t benchmark such performance to indices. Often, when they do so, they use benchmarks that portray their investment results in the most favorable light possible. The DOL has attempted to address this shortcoming by requiring benchmarking to broad-based, appropriate indices that are unaffiliated with the investment firm.

However, because the rule does not mandate that performance be provided net of expenses, some providers may report gross returns in order to compare more favorably to benchmarks. Investments that provide a fixed rate of return do not call for a performance vs. benchmark history to be listed but require only the current credit rating and period for which that rate is in effect.

2.Fee and expense information.An increasing number of investment providers have been providing fund expense ratios in conjunction with their performance information. This information will be mandatory. In addition, the expense ratio will need to be expressed in a dollar amount, as a cost per $1,000 invested in the fund.

That requirement might be the single most enlightening element of the chart for plan participants, as studies have shown that participants comprehend dollar amounts much more easily than percentages. Moreover, sales charges, charges to prevent market timing, and any other additionalcharges related to holding shares will have to be disclosed.

On the flip side, participants will still not know the precise dollar amount of fees charged to their accounts because of the multiple transactions that take place in a retirement plan. Other significant expense factors, such as trading costs--which can equal or exceed the expense ratio for certain actively managed funds--will largely remain a mystery to plan participants.

Still, it is obligatory to list the portfolio turnover in the performance section of the investment website. It can serve an indicator of trading costs, as higher turnover results in increased trading costs. Lastly, revenue sharing (e.g. 12b-1 fee and sub-TA fees) must be disclosed to participants.

3.Annuity Information. Plans that use fixed and variable annuity investments are now subject to fairly detailed disclosures, including an explanation of how the annuitization and death benefit works, as well as surrender charges.

Nevertheless, the new requirements contain some significant omissions, such as a breakdown of mortality and expense charges, which can be a significant cost component of variable annuities.

The DOL rule is a significant step forward in informing participants as to what they are paying. Yet participants are still far from cognizant of the true annual cost of their retirement investments.

Michael Webb TGPC, AIF, CEBS, is vice president of Cammack LaRhette’s retirement services practice, where he provides retirement plan consulting services spanning several tax-exempt industries. His background is in operational compliance where he is primarily responsible for establishing retirement plan operating systems to comply with the latest federal regulations, through onsite support of human resources, information systems and payroll departments of large employers. He is a registered representative with the Financial Industry Regulatory Authority (FINRA); was awarded the Accredited Investment Fiduciary designation from the Center for Fiduciary Studies; is a Certified Employee Benefits Specialist (CEBS) and a Tax-Exempt & Governmental Plan Consultant (TGPC). His affiliations include chair of the National Tax Sheltered Accounts Association’s (NTSAA) educational committee, member of the National Conference Committee, and instructor for the CEBS program of the International Foundation of Employee Benefit Plans.

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